Choice Equities Capital Management recently released its Q3 2020 Investor Letter, a copy of which you can download here. The fund posted a return of 35% (net) for the quarter, outperforming its benchmark, the S&P 500 Index which returned 8.9% in the same quarter. You should check out Choice Equities Capital Management’s top 5 stock picks for investors to buy right now, which could be the biggest winners of 2021.
In the Q3 2020 Investor Letter, Choice Equities Capital Management highlighted a few stocks and Select Interior Concepts Inc. (NASDAQ:SIC) is one of them. Select Interior Concepts Inc. (NASDAQ:SIC) is a diversified product and service company with market leading capabilities in interior selections and merchandising. Year-to-date, Select Interior Concepts Inc. (NASDAQ:SIC) stock lost 14.5% and on December 14th it had a closing price of $7.83. Here is what Choice Equities Capital Management said:
“SIC – Select Interior Concepts, Inc. is a company I have had my eye on for a while now. As an investor with an affinity for building products distributors and the sometimes-eye-popping long-term shareholder returns these companies have a knack for producing, I have been intrigued with its potential for some time. Much like we found a few years ago in our comparison of a young SiteOne Landscape Supply, Inc. (SITE) to industry paradigms Pool Corporation (POOL) and Watsco, Inc. (WSO) (see here for the case study), SIC stands to benefit from the same type of industry structure that has enabled these companies that have staid mid-single digit organic sales growth profiles to produce some of the most impressive total shareholder return records around. Accordingly, this was one of the companies I spent a great deal of time with at the Las Vegas builder show eight months ago.
By way of introduction, the company consists of two segments that primarily fulfill product needs of residential builders. Each has a market leading position in businesses where local scale and geographic presence matters. Residential Design Services (RDS) provides an outsourced interior design and installation service to its homebuilder partners. Its primary value add is to assist prospective homebuyers in navigating the cumbersome process of managing the selection and installation of the many various flooring, countertops and cabinet products that go into a new home. The company procures and installs the products thereby simplifying a process that often has a number of subcontractors coming and going at various and somewhat unpredictable times. The Architectural Surfaces Group segment (ASG) is the largest distributor of natural and engineered stone slabs in the country. These products are sourced across the globe and typically sold directly to builders, countertop fabricators and kitchen and bath dealers who finish the installation from there. Due to the outright bulk of the products and desire of homeowners to see their slabs given the heterogenous nature of stone patterns, these products can be difficult to source and showcase in adequate supply for smaller operators.
With ASG as the number one player and RDS as a clear-cut number two, both segments have market leading positions but also big white space opportunities remaining where they do not have a presence geographically. Both businesses are also beneficiaries from growing economies of scale as advantages in purchasing and distribution create savings they can then pass along to their customers, which enables them to then attract more customers, thereby perpetuating the distributors’ virtuous cycle. As we have seen in other building products rollup stories, if the acquirer does deals responsibly at sensible multiples, acquisitions can be a productive use of capital as the company is essentially just buying smaller versions of itself. And by spending within their annual cash flow generation, they can typically add 5% to 10% a year to topline growth. Altogether, these dynamics create an opportunity for the company to embark on a multi-year market consolidation opportunity via accretive acquisitions that can be quite rewarding.
Despite these promising characteristics, it has been little more than bumps and bruises for SIC since coming public via the unorthodox route of a direct listing in 2018. Some of these troubles seem attributable to plain misfortune, though there have been some missed opportunities and operational missteps along the way too. Clearly, timing has been inauspicious from the start. The company came public right as housing was entering a mini recession in 2018. SIC’s geographic mix, which at one point saw 80% of RDS sales coming from California, was ill-suited for the times considering that state’s housing market was going deeply negative as it digested the negative impact of SALT taxes there. Microtrends within the housing market would go against the company as well, with builders leaning into production of smaller homes and buyers doing less upfitting. Despite the softness, corporate SGA would remain stubbornly high. Then there was a distracting activist campaign, subsequently abandoned. Shareholder turnover would follow. And then a pandemic. Finally shares would bottom this summer after the company fell out of the Russell 2000. So, for much of the company’s public life, company fundamentals would underperform national housing market metrics and frustrate shareholders.
But things appear to be changing for the better. Starting at the top, changes at the board level have led to a change in leadership as Bill Varner, a seasoned building products CEO has joined the team. He has impressive experience within the industry, most notably taking United Subcontractors (an interiors installation provider) from -$20M of EBITDA to $50M of EBITDA in just six years. Another positive sign is that he is bringing some of his lieutenants with him, all of whom have been incentivized with equity heavy compensation packages. Recently the company identified $20M of costs they can take out of the business. The California housing market, which RDS has diversified away to ~50% of its segment mix, is now performing strongly, as are most other regions currently. Their digitally enabled Momentum Design product is small but gaining traction and leading to new customer wins. And though it seems unlikely to expect the company to immediately return to the acquisition market, it seems more likely than not this will become a meaningful driver of results in the medium term.
Perhaps comparisons to more mature players WSO, POOL or SITE which all trade north of 20x 2020E EBITDA may be a bit optimistic or premature. So maybe comparisons to younger building products distributors like Installed Building Products, Inc (IBP) and TopBuild Corp. (BLD) who trade around 14x to 15x 2020E EBITDA and likewise lean a bit more cyclical make for a better comparison. Even so, all of the necessary preconditions for success appear present. SIC has a proven management team, a strong market position and a long runway for growth in businesses that can benefit from accretive acquisitions. So, as we look out over a multi-year horizon, it is not unreasonable to see a big opportunity here. But with SIC currently trading around ~6x 2020E EBITDA, we certainly are not paying for that outlook.”
In Q1 2020, the number of bullish hedge fund positions on Select Interior Concepts Inc. (NASDAQ:SIC) stock decreased by about 18% from the previous quarter (see the chart here), so a number of other hedge fund managers don’t believe in SIC’s growth potential. Our calculations showed that Select Interior Concepts Inc. (NASDAQ:SIC) isn’t ranked among the 30 most popular stocks among hedge funds.
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Video: Top 5 Stocks Among Hedge Funds
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Disclosure: None. This article is originally published at Insider Monkey.
